Tuesday, February 3, 2009

Retaliation – the Problem with Expenditure-Switching Policies

As I tried to present the discussion so far as to the Buy American provisions floating around Congress in their hotly debate ideas as to how to stimulate U.S. aggregate demand, Barkley reminds us that foreign governments might retaliate with their own expenditure-switching policies:

In 1930, the US passed the Smoot-Hawley tariff in order to preserve US jobs. This was a fixed exchange rate world under the gold standard. There was full bore reaction by other countries, most significantly the British Commonwealth ones, but others as well, and world trade declined sharply, certainly exacerbating the plunge into the Great Depression, although the degree of its role remains a matter of debate. However, I am unaware of any economist anywhere who argues that American jobs were saved by this catastrophic policy. Now there is a hard international political economic reality here that is being ignored. The just-ended Davos conference included fiercesome denunciations of the US for having triggered what is now the most widespread global recession ever. Merchandise trade declined in November at an annualized rate of 45%, while the big conference in Washington supposedly agreed on avoiding protectionism for at least a year, and in mid-January the US put a bunch of trade sanctions on the EU (no more Roquefort cheese to be had in the US anytime soon). Without doubt, such a stupid move by the US would this time also trigger massive reactions and the very serious danger of a full-blown trade war. No way this is going to help the world economy, much less the US one, although certain sectors might do better in the short run (Krugman's argument).

To be fair, Paul Krugman is hoping for more expenditure-adjusting policies:

Now ask, how would this change if each country adopted protectionist measures that “contained” the effects of fiscal expansion within its domestic economy? Then everyone would adopt a more expansionary policy — and the world would get closer to full employment than it would have otherwise.

Whether or not such a global scale movement towards autarky would induce more global fiscal stimulus is an issue I’ll leave to those smarter about these things than me, but I thought it was interesting that even Mitch McConnell understands what Barkley is saying:

I don't think we ought to use a measure that is supposed to be timely, temporary, and targeted to set off trade wars when the entire world is experiencing a downturn in the economy

While we are experiencing some improvement in our net exports, the reason has more to do with our falling demand for imports than it does with rising exports. Real exports fell during 2008QIV and it is not surprising to see why if one reviews the information in table 1.1 of the IMF’s World Economic Outlook. World output slowed in 2008 – particularly among the advanced economies. This slowdown is projected to continue during 2009. The growth in world imports/exports also slowed – particularly among the advanced economies.

Any attempt by the U.S. to increase its aggregate demand via expenditure-switching policies will reduce the net exports of our trading partners. Given that our trading partners are also likely to face insufficient aggregate demand during 2009, Senator McConnell’s concern about setting off a trade war appears to be a legitimate one.

11 comments:

Anonymous
said...

On something of a tangent, the Smoot-Hawley tariff was a large tariff increase on top of already high tariffs during the 1920s [at that time, tariff revenue was comparable or higher than income tax revenue]. The adverse effects of the Smoot-Hawley tariff merely evidence the problems with excessively high tariffs, not with all tariffs whatsoever.

One more reason to boost the spending on rail and transit, where the Buy American provisions are already embedded in the underlying programs, and where all our main trade partners also already have strong domestic content requirements.

The real threat here is not just expenditure switching reactions, but reactions that go beyond buy local plans to broader retaliation. There is no reason this could not happen, and plenty of reason to believe that it might.

At best, the Krugman scenario has no net gain for what he proposes. The gain is from all the countries having fiscal stimuli simultaneously. If all have buy local progranms with no further retaliation, there may be no net loss, but there is no net gain. If there is retaliation further, then we start getting into 1930 territory. The only way we have a gain is if the US does it by itself, and nobody else does. But the likelihood of that is, well, anybody who believes that, I have a bridge to sell you.

The tariff rates of Smoot-Hawley were a bit over 100%. We just put 300% on Roquefort cheese (take that, Frenchies!).

It's not a question of net loss or net gain, but a question of the welfare of the USA. Countries with overcapacity in manufacturing with these tariffs would have to shrink their capacity. Countries with undercapactiy would have to expand, under this sort of tariff regime. The USA would do well, other current accout deficit countries would do well. The surplus countries, esp china, not so much.

There isn't any "threat" here. It is a lot of ideological crumb cake. The real threats run in the opposite direction.

We have been suffering trade deficits for 30 years and it is high time that the other nations of this world (and we) started producing what we need and forgetting about making the multinational corporations and their stockholders more and more wealthy.

China does not spend the money we send them on our goods or on anyone else's goods. That save it up in T-Bills and that is why the currency does not float. The multinational corporations are getting a free ride on the backs of the producing class. And tariffs are the most direct method to combat both the Chinese saving and the support for the world wide policeman. Bring on the tariffs. "I'll call yer 6% and raise ya 3% more".

I'm with TheTrucker on this one. You're not dealing with a Free Market, so let's stop pretending we are.

The exemption is already in the bill. And I'm not the only one—or even the only one at your former blog—who is willing to point out that there are already protectionist policies going around.

Unlike 1930, as Nick Rowe noted, we have (mostly; exception at the link above) floating FX rates. Countries who recover quicker will be affected there; I can live with that, and I suspect the relative elasticities make it a better call anyway.

Some Brit was on BBCNews tonight whining about the evils of "buy American." And Barkley is going around whining about Smoot-Hawley, without mentioning that you had both fixed FX and The Gold Standard (with flows there much more important than the tariff; see Bernanke).

The law currently reads "buy American" if you can, if it's not in the public interest not to do so, and if it won't significantly increase the cost of the project. I could drive a Mexican truck through that loophole if I was as looped as Willie Nelson and Slim Pickens were pretending to be near the end of Honeysuckle Rose.

The incessant whining from the "but free trade would be better" crowd, as usual, pretends that trade is free while forgetting that the tariffs and protectionism are rampant elsewhere.

The two choices are not generate three or four American jobs with American taxpayer monies or let us here in the Great White North ship you a bit of aluminum. Both of those are going to happen anyway.

The worst-case scenario: it goes to the NAFTA courts or the WTO, the Obama administration gives its already-patented wink-and-a-nod (op. cit. Exec Comp, Hankie-Pankie II) and someone gets compensated. Meanwhile, for a while, some markets become a little freer than they are when only one side is playing Protectionist.

Anonymous (why is it that some of the stupidest comments are sent by this famous person?),

I do not see your argument about over and undercapacity following at all, anymore than I did trucker's argument about how countries will be definitely affected in particular ways depending on whether they are surplus or deficit countries, although some of the most severely collapsing economies right now, as world merchandise trade is collapsing, are some of the high-exporting East Asian miracle economies, such as Japan, Taiwan, and South Korea.

In your remarks about how all you care about is US welfare you sound worse than Lou Dobbs. We are in a world in which virtually everybody else in the world is blaming us for what has happened, and with very good reason, and you have the unmitigated gall to come out with such nauseating tripe. Yes, you had better stay "anonymous." Puke.

trucker,

Well, we had all better hope that China is willing to continue to lend us money during the upcoming stimulus, especially if we spit in their faces with this stupid piece of the legislation. If they do not, it will not work. Interest rates will soar and all those hysterical stories about crowding out that the conservatives love to haul out might well come to pass.

Ken H.,

For starters, I have never co-blogged at Angry Bear, and I am fully aware that many who are on my end of the political spectrum do not agree with me about the trade issue. In the very thread you linked to, some of my comments were censored by rdan, or whoever it is that does the censoring over there. I took rather vigorously after some especially assinine remarks that remain there. Not Politically Correct, Oh Goody.

I did not comment on Nick Rowe's piece partly because it was such a pathetic piece of tripe. Fixed rates broke down when the UK went off gold in August 1921. It was after that that all hell really broke loose and that what had been merely a pretty bad recession really went plunging into the Great Depression. Sure, the countries that devalued first and fastest got gains ahead of the others, starting with UK, which had been in a slump since Churchill insisted on repegging to gold at the prewar rate in the mid-1920s, first into the depression and first out. But this was simply part of the general "beggar thy neighbour" policies that went along with the trade war that sent everybody into the soup together.

I never said that we had free trade. It is very hard to get to free trade, as it involves all countries involved in negotations having to give things up (and not just their rich people or their poor people, but some of both). We have spent over a half century trying to undo the damage done in the wake of Smoot-Hawley, only now to have people like you all rushing like lemmings to undo it as fast as possible.

Oh, and as for the NAFTA courts, yes, Canada is likely to be the most hurt by this as our largest trade partner. What is it with all these people who want to stick it to Canada? Were they responsible for our subprime mess with all their lumber coming into the US? Are we resentful of them that their banks are the safest in the world and have had no collapses so far (and did not during the Great Depression either)? Are we as a nation really the caricature pictured on South Park who want to "blame Canada"? Sheesh. This would be funny, except that it is so far from it.

"Well, we had all better hope that China is willing to continue to lend us money during the upcoming stimulus, especially if we spit in their faces with this stupid piece of the legislation. If they do not, it will not work. Interest rates will soar and all those hysterical stories about crowding out that the conservatives love to haul out might well come to pass."

To the extent that we tax the stuff coming into the country from China and use _real_ fiat money then we won't have to borrow any money from the Chinese. Even if we run the monetary system as is we do not need to borrow from China. I am beginning to suspect that some people have religious predispositions that are not amenable to facts and realities. Investments in infrastructure are capital investments, and the creation of additional money devalues the current money. These realities seem to be left out of the religious sentiment concerning free trade. The major reality is that we still have an elected government and that the people of this country are not going to go quietly into banana-ville.

Imports from China in 2008 were around $312 billion. If the stimulus package passes we are going to be runninga budget deficit of around $1 trillion or so. You are proposing a 200% tariff on Chinese imports, which if put in place would not raise the money as it would price Chinese goods out of reach of US consumers?